ICRA: Adoption of IndAS 115 dents networth of major realty players, while slowing down revenue recognition

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The implementation of IndAS 115 w.e.f from April 01, 2018, has had a significant impact on the financials of the real estate companies. According to a study carried out by ICRA encompassing nine[1] listed entities forming part of BSE Realty and NSE Realty, where-in these entities applied project completion method (PCM) compared to the earlier adopted percentage of completion method (POCM),

ICRA: Adoption of IndAS 115 dents networth of major realty players, while slowing down revenue recognition

have had to restate their net-worth post the application of IndAS 115 with a retrospective effect. The companies had to reverse the gains recognized on projects that were not completed as on April 01, 2018. The cumulative effect of applying this standard is recognized as an adjustment to the opening balance of retained earnings, only to the projects that were not completed as at April 01, 2018.

According to Mr. Shubham Jain, Vice President and Group Head, ICRA, “The application of IndAS 115 has impacted the financial reporting. The impact has been more pronounced on the networth, revenues and profits. Companies had to restate the networth at the end of March 31, 2018, leading to deterioration in their gearing levels. Further, the adoption of IndAS has deferred the revenue recognition.”

The cumulative impact on the net worth of these nine companies has been to the extent of Rs. 11,279 crore, an 18% downward revision from their March 31, 2018 reported networth under the earlier accounting regime. The nine entities had a cumulative networth of Rs. 62,005 crore prior to the implementation of IndAS 115 and the same stands restated to Rs. 50,726 crore.

The cumulative debt for these entities was Rs. 42,517 crore at the end of March 31, 2018. Consequently, the revised gearing for the sample set deteriorated from 0.69 times to 0.84 times. This is in line with ICRA’s earlier article ‘IndAS 115 will improve disclosure and compliments recent amendment to IBC’ dated June 12, 2018.

Post the application of the new accounting standard, the revenue, which is being recognized, for the on-going projects, on project completion method, declined by 23.6% in Q1FY2019 compared to the previous quarter. Revenues in Q1FY2019 was Rs. 6,771 crore in comparison to Rs. 8,864[2]crore in Q4FY2018 for the companies under study. Further, the total comprehensive income also declined to Rs. 743 crore compared to 2,409 crore for the period under consideration.

Mr Jain added, “Users of financial statements will have to dwell deep while the company disclosures will also have to improve further in terms of pipeline of project completions, project-wise revenues and profitability in order to appreciate the financial statements better.

This stems from the fact that henceforth we expect quarterly revenues and profitability to depict significant volatility, thus disclosures will help them understand it. While the adoption of IndAS 115 does not impact the cash flows of the company, the reversal in retained earnings on account of profits from on-going projects gives good visibility on future profits that will be recognized over the near-to-medium term as and when these projects get completed.”

Earlier, under POCM, the revenues and corresponding costs were gradually recognized upon achieving certain thresholds. Post clearance of the thresholds, the key parameters driving the revenues and costs were the project sales achieved in terms of the area, collections received, and percentage of cost incurred against the budgeted cost. Companies which had multiple projects having varied range of project profitability were in-effect showing a blended margin for the development portfolio where the thresholds had been met. Going forward, the companies will be recognizing revenues for the sales achieved once the project is completed. Hence, it will become essential for the companies to provide necessary data points like project completion dates, project profitability etc. to understand the quarterly P&L trends better.